Primary Residence and Rental on Same Parcel, Legal Pitfalls?

Question

Hey, BiggerPockets!

I'm a long time reader of the forums and I have a feeling that among the wealth of knowledge here, that someone would have an answer to this question. Any of your sage wisdom, advice, and comments are appreciated! First off, let me preface my question with some backstory.

I've been keen on the idea of rental properties for some time now and have finally made the plunge. My original idea was to purchase a multi-family home and house hack, but a better deal came my way. In just over a week, I'm due to close on my first home. To me, it seems like the perfect setup, but I'm concerned about the legal repercussions in the event of a lawsuit.

The primary home is about 1650sqft, 3 bed, 2 bath on a 3 acre parcel with a smaller 625sqft, 1 bed, 1 bath "mother-in-law" house tucked to one side of the property. Each house has separate utilities and even separate addresses. The former owner was allowing a friend to live in the small house rent free. Being that this friend is due to vacate upon closing, I'm looking to start generating cash flow by renting it ASAP.

My first thought was perhaps an umbrella insurance or liability insurance policy would cover losses, but I want to set this up so that my personal assets are untouchable in a court of law. Is this something my homeowners policy would cover? Does my homeowners policy cover the tenant since they are on the same piece of land?

Now, I know it may seem improbable, but I want to cover my bases in the event of a sue happy tenant. (I'll be screening them, so hopefully we can avoid those ones.) Am I being too paranoid about this? I know that advice posted here is not substitute for that of an attorney, but do I have reason to meet with one?

My original idea was to form a holding LLC and subsequent LLC's for each property, but I'm not sure I can do that unless I split the parcel. (A split would not be ideal, as I plan on making the larger house my primary residence.) Like I said, I'm new to world of real estate renting and I want to do things right so that I'm protected. As my grandfather always said, "an ounce of prevention is worth a pound of cure."

Thank you for your time and I wish you all a belated Happy New Year!

Eamonn McElroy · Answer

@Zach Gentner

"but I want to set this up so that my personal assets are untouchable in a court of law"

An LLC is not automatic protection against a lawsuit.

As manager of the LLC, you would likely also be named in your individual capacity along with the LLC in any suit.

If you are this worried about a lawsuit, it is logical to believe you have substantial assets. If you have substantial assets, you should engage an attorney familiar with asset protection (and ideally estate planning) to mitigate this risk.

Kase Knochenhauer · Answer

@Zach Gentner - very cool! That's pretty ideal for some private house hacking.

While I'm not an attorney nor specialist in the law, I think we can make a few a assumptions:

1. If you are purchasing with a conventional mortgage, you'll have to purchase in your own name. It will be up to you and your attorney if you want to quit claim the property to an LLC (only one LLC, not two) after closing. You'll have a legal hedge of protection, however, some argue that your lender could call your mortgage due (even though I've never seen this occur).

2. I own a few properties like this and we just have one insurance policy per parcel.

3. A third barrier is to have a property management company run the rental property. That way your new neighbor won't know that you're the owner and will be less likely to knock and ask for things to be worked on. This is more of a convenience than legal protection though.

Nice find!

Nick Van Bibber · Answer

@Zach Gentner

In order to have an umbrella policy, you must meet a certain threshold of liability coverage first in order for an umbrella to be written and coverage offered. The umbrella is in addition to what you currently carry on your auto and/or homeowners. What amount of coverage that minimum threshold needs to be is dependent on the insurance carrier you use.

Zach Gentner · Answer

Thanks for the follow up, guys. I'm also interested in which types of insurance you might recommend for my situation. Are both liability and umbrella policies important to have in my scenario?

I'm financing the home myself with a 20% down payment to avoid PMI. I'm also aware that an LLC does not protect me entirely, but I've heard that it makes it more difficult for a lawyer to seek damages from my personal assets. (I don't have too many assets. None are what I would call tangible, but I do have what I would consider a sizable amount invested in the stock market for my age.)

I've also considered property management, but I feel that the tenants would know I am the homeowner being that we are in such close proximity to them. This would be another reason I'd like to form an LLC. I could put something like XYZ Investments as the 'agent' on our rental agreement. Unless the tenant does a search online, they wouldn't know that I am the owner.

Primary Residence and Rental on Same Parcel, Legal Pitfalls?

Primary Residence and Rental on Same Parcel, Legal Pitfalls?

Most Popular Reply

4 Replies